Automation Savings, A Complete Guide to Get the Most Accurate ROI Possible

Enrique Morales

Americas Automation Leader at Honeywell Aerospace

Learning Objectives

Calculating savings for an automation project is not as simple as payback, things to consider include, direct and indirect labor, maintenance, capex, opex, materials, inflation; with this presentation you should be able to decide how to calculate the ROI of the project and get the budget to make it happen.


Key Takeaways:



  • Learn what are the hidden costs of an automation project

  • Learn about the differences of hard and soft savings

  • Learn to calculate the most accurate ROI possible for an automation project


"Automation savings are complex when they are calculated correctly."

Enrique Morales

Americas Automation Leader at Honeywell Aerospace

Transcript

Have you ever calculated the financials of an automation project and then been heavily rejected by the CFO or received complaints from some of the team members over extra expenses they have to execute? I have been there, so let me help you get it right on your first try.


Hello, welcome to Payback Period Calculation for an Automation Project. I am Enrique Morales and I will be your host today. You probably don’t know me, and that’s fine, but let me introduce myself. I love automation. It all started after college. I landed a job as a Maintenance Engineer and getting bold really quick on automation projects. Then, I began my [inaudible], and after joining Honeywell like 5 years ago, I became a Product Manager for API’s and eventually moved to 100% Automation.


Let’s start by defining what I will be calling Quick Payback and fully analyze payback. Quick Payback is a simple general calculation of costs divided by the annual savings. I am calling it quick because we are just calculating the cost of a project. Let’s say you want to have a machine that is going to cost $2 million, and you say you are going to be saving $400,000 a year, it’s going to be five years, so that’s quick. Let’s just start the project. You go with your boss, your executive officer and say, “You know what this machine is going to cost $2 million, it is going to pay by itself in five years.” That’s how you use a quick payback, but it’s not accurate, we all know that. That’s why we need to calculate a full analyzed payback, and that’s what’s going to be discussing today. We’re going to be talking about hidden costs, indirect like in the labor, negative expenses, materials, and hidden savings as well like attrition and inflation. The full analyzed payback is used for calculating the exact costs and savings of the machine, and that’s what you’re going to be presenting when you launch the project for real to your leaders.


Before moving on to the main topic, let’s discuss one more thing: funding with CAPEX or OPEX. CAPEX are major purchases a company makes that are designed to be used over the long term, and OPEX are the day to day expenses a company incurs to keep its business operational. They will have different ways of impacting your business financial numbers, but we’re not here to discuss taxes. Most of the automation projects will fall under the CAPEX category. This is how most, if not all, of the automation companies hold their projects. This is mostly beneficial for long term projects, so this is what I will cover today. Keep in mind that there are a handful of companies starting to offer OPEX as a way to acquire their solutions. At some point, this is something that you will have to discuss internally to see if this is something that will work for your organization.


Currently, all our projects are funded as CAPEX. These may change in the future, but our consensus at this moment is that OPEX is beneficial for short lived projects and not for long term projects. The biggest expense, hopefully, is the cost of your solution, followed by depreciation and also consider maintenance costs. At this point, it seems very easy to remember but well, don’t forget to include spare parts, machine transportation, facilities, lay-off changes, indirect labor, [unintelligible] expenses, and material. At this point in time, you will need to remember that we have increased demand for electronics and plastic vessels so material might be scarce. Your project will need considerable amount of material for at least four stages in the project during liquidation because you will need to send samples to your vendors. Also, they will require additional parts to send to their vendors in order to quote a certain field or somethin. You will also need materials for when the break starts. You will need a lot of material at this point, but nothing will be compared to the quantities required for the book in the machine.


Once it’s closer to completion and the quantities required for validating the machine, you will need to validate the machine thoroughly. For that, you will need to send a lot of material to your vendor. By a lot, we’re talking thousands of pieces. Some of these material may be recoverable, but most of them is not going to be recoverable. It’s going to be scrapped, so consider that. Another hidden cost might be labor transferred to a different process. Sometimes, the vendors suggest placing the material in special containers. When you replace the labor, that’s going to be certain material in your process but you will have to transfer that labor to the process of certain material to put it in those containers. Some other different things that will be done by the hidden labor, like researching material, or changing the packaging, it all adds to the automation costs. You may receive, at this point, a material in bulk, and someone suggest to use a different packaging, it’s gonna cost. You need to consider that as well.


Savings. Here, we have two rows for FBA products and sustaining pros. Let’s review sustaining first. Direct labor, it can be identified basically, you calculate how many people the machine is going to save. And you know how much delay what you’re going to be saying. Also consider indirect labor. Sometimes, there’s people checking the product or repairing it, you need to consider them as well. Don’t forget the cost of poor quality. You can identify that easily, it’s a scrap, production losses due to transportation and stuff, so that’s easily identifiable. And here the savings to consider are direct labor that will not be required when demand increases. So let’s say your machine is capable of producing 2 million pieces. And at this moment, you’re only losing 2 million, you have a hefty amount of brothers that you will be able to produce with a machine without hiring people, so that’s also savings. You will also save the equipment required to produce that extra million units man. What else? Salary inflation and additional expenses in addition is high in regions like Mexico, where I’m based. The cost of high new labor should be included in the calculation as well.


MPI savings are funding considered the same savings as sustaining and it can also be funded to increase capacity. Sustaining products have small growth curves. However, MPIs have exponential curves, [inaudible], so once product sales hit the top. It is for this reason that a well planned automation project can respond faster to this curve when demand increases.


Let’s have an example. Let’s say your solution costs a million, you will need probably an indirect labor increase of 50k because you will need an Engineer or a Technician. I’m not based on any costs, I’m just doing the costs for the sake of the example. Then, for a 2-minute break, you may need 10k a year for maintenance. You have right now 60 people on your manual labor. After automation, you are going to have only 10 people. You’re going to be cutting a net save of 50 direct labor personnel assuming a cost of 11.7k. That’s roughly $5 per hour per operator, and a demand increase of 5% a year and inflation 5% a year. I use a percent because it’s easy. Every time you lose an employee, hiring costs $500, that’s going to be our example.


You will be able to see over here in our financial sheet, all the information, the cost of the solution is 2 million on year 1. And then, you’re going to have to hire 50k indirect labor personnel and you’re going to be paying that for, in this case, 10 years. The maintenance is going to start happening at the 2nd year, and it’s going to be $10,000. Over here, this row, you can add your material and different stuff, but this tool does not have the option to select what’s this topic, so I didn’t want to confuse you. If you go here, you can also add those expenses. Over here, your labor savings, this is 50 times 11.7k, and it’s going to calculate the inflation. Then, since we have a 5% growth every year in demand, we assume it’s 5% increase in operators as well, so you’re going to have to hire, in this case, like three operators, then three and a half, and so on. You’re going to save due to attrition, which is going to be high on this because we have a very high attrition is going to be $500 per person. We also consider this and it’s going to be impacted by the amount of operators that are increased due to the demand.


This is how the two are calculated. The cost of savings is going to increase every year due to inflation. If we compare this to the previous one, we have $505,000 over here, and now the two inflation, which is 5% a year, it goes high. If you calculate it, you’re going to be short in your payback period calculation. Every year is 5% extra, so in the end, it’s going to be 1 million in 10 years compared to $164,000. I set up a 10-year depreciation period, but you will have to choose what your finance team tell you. We usually use 710 and 12 depending of what kind of [unintelligible] it is. So, this is the gross profit.


Finally, our calculation after solving all these items, have the formula. I will help you understand a little bit better. After taxes and stuff, depreciation, and all the expenses that we have are here, we have a payback period of 4.2 years. This will be higher if we didn’t use inflation, if we didn’t use the avoided cost of future labor, and the attrition cost. As you can see, all adds up. In this case, a payback period is 4.2 years. Look at the example I did but we have projects that we have been able to move from 3.5 years to 2.9 years, which is much better and easier to sell to our financial team. Automation savings are complex or when they are calculated correctly, they leave no room for error.


Thank you for staying here to the end. We appreciate it. If you need any help or questions, don’t hesitate to post them on the platform or contact me on LinkedIn. [Unintelligible], thank you very much.


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